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2 yr note auction solid, what’s that say?

United States

The 2 yr note auction, very sensitive to expectations for Fed policy, was solid. The yield was about ½ bp below the when issued and the bid to cover of 3.03 was well above the 12 month average of 2.70 and the best since November 2015. Also of note, direct and indirect bidders took down 75% of the auction, well more than the one year average of 58%.

Bottom line, at least measured by this auction, the buyers are really doubting the path of many more rate hikes from the Fed. Odds by December are only around 50/50 for one more and the fed funds futures are only fully pricing in one more hike by July 2018. We all debate this everyday about the mixed messages from the different markets but the Treasury market is speaking loudly about its view on growth and inflation. Forget about just looking at the trajectory of the yield curve, if the market thinks the Fed will only hike rates once by July 2018, that is saying something about its view on growth (punk) and inflation (falling). This said, it is becoming clear that the Fed might initiate QT before the next rate hike but even so, there is apparent worry about what this will mean for the macro environment. The Fed seems to think QT won’t be a big deal and that’s why they are mostly likely to start it. On more rate hikes, I think it’s certainly fair, based on the Fed’s reputation, for the market to doubt the Fed’s willingness to further tighten via the fed funds rate in light of both the economic data and the recent inflation stats.